IRS Letter 226-J and the Employer Shared Responsibility Payment: What Every Employer Should Understand Before Paying the IRS

A proposed penalty can reach hundreds of thousands of dollars. It is also frequently wrong, and the proposal stage is your best chance to fix it.

If you have just opened an IRS notice proposing an Employer Shared Responsibility Payment (“ESRP”), you are likely feeling some combination of confusion and alarm. The proposed amount can reach hundreds of thousands of dollars, the rules behind it are dense, and there is a firm deadline to respond.

These penalties are generated largely by automated systems that match employer filings against Health Insurance Marketplace subsidy data. When that data is incomplete, miscoded, or based on incorrect assumptions about who is a full-time employee, the result is an inflated assessment. A careful, fact-based response can often reduce the proposed liability substantially, or eliminate it entirely.

What Is the Employer Shared Responsibility Payment?

The ESRP is a penalty that may be assessed against certain employers under the Affordable Care Act (“ACA”). The ACA does not require employers to provide health coverage. Instead, beginning in 2014, an employer that meets the definition of an Applicable Large Employer (“ALE”) can be liable for an “assessable payment” under Internal Revenue Code § 4980H if it fails to offer adequate, affordable coverage and at least one full-time employee receives a subsidy through the Marketplace.

Generally, the IRS may propose an ESRP against an employer that:

• Is an Applicable Large Employer;
• Failed to offer qualifying coverage as required by law; and
• Had at least one full-time employee who received a Premium Tax Credit through the Marketplace.

The IRS proposes the penalty through Letter 226-J. Many employers assume the proposed amount is correct. That assumption is often a costly mistake.

What Is Letter 226-J?

Letter 226-J is the IRS’s initial notice proposing an ESRP assessment for a specific calendar year. It is a proposal, not a final assessment. The packet generally contains the proposed penalty amount, the months involved, the count of full-time employees the IRS attributes to you, an Employee Premium Tax Credit Listing (Form 14765), a response form (Form 14764), and instructions for responding.

Critically, you still have the opportunity to challenge the calculation, provide corrections, submit supporting documentation, and reduce or eliminate the proposed liability. The proposed amount is built month by month and employee by employee, which means it can be unwound the same way.

Understanding the Two ESRP Penalties

Section 4980H contains two distinct penalties. Knowing which one applies, and whether it applies at all, is central to any defense.

The “No-Offer” Penalty: IRC § 4980H(a)

This penalty applies when an ALE fails to offer minimum essential coverage to at least 95% of its full-time employees (and their dependents) and at least one full-time employee receives a Premium Tax Credit. It is the more dangerous of the two because it is calculated on nearly the entire full-time workforce, not just the subsidized employees. The annual formula is:

The penalty amounts are indexed for inflation, and the figures used in any notice are tied to the tax year being assessed, not the year you receive the letter. For example, the annualized § 4980H(a) amount was $2,880 for the 2023 tax year and rises to $3,340 for failures occurring in 2026. These figures began at $2,000 in 2014 and have climbed steadily, so a notice covering a recent year will reflect a substantially higher number than the original statute suggests. The penalty is assessed monthly, at 1/12 of the annual amount for each month a failure occurs.

The “Unaffordable Coverage” Penalty: IRC § 4980H(b)

This penalty applies when an employer does offer coverage, but the coverage was unaffordable or failed to provide minimum value, and a full-time employee received a Premium Tax Credit. Unlike the no-offer penalty, it is calculated employee by employee, only for those employees who actually received a subsidy. Like the no-offer penalty, the § 4980H(b) amount is indexed and tied to the tax year assessed: it was $4,320 for the 2023 tax year and is $5,010 for 2026, applied per affected employee. Importantly, the total § 4980H(b) penalty can never exceed what the § 4980H(a) penalty would have been for that month.

“Affordable” has a specific meaning that also changes annually. Coverage is treated as affordable if the employee’s required contribution for the lowest-cost, self-only plan does not exceed a set percentage of income, 9.96% for the 2026 plan year, up from 9.02% in 2025. Because employers rarely know an employee’s household income, the IRS permits three affordability safe harbors based on information the employer does have: the Form W-2, rate-of-pay, and federal poverty line methods. Whether coverage was affordable under one of these safe harbors is frequently the deciding issue in a § 4980H(b) dispute, and proper documentation of the safe harbor used is essential.

Full-Time Employees vs. Full-Time Equivalents: The Most Common Source of Error

This distinction is among the most misunderstood areas of ACA compliance, and it drives a large share of erroneous assessments.

Full-Time Employee. For ACA purposes, a full-time employee is generally one who averages at least 30 hours of service per week, or 130 hours per month. Only actual full-time employees are used to calculate the ESRP.

Full-Time Equivalents (FTEs). FTEs are a calculated figure created by aggregating the hours of part-time employees (total part-time hours in a month divided by 120). FTEs are used only to determine whether an employer is an Applicable Large Employer, that is, whether it averaged at least 50 full-time employees plus FTEs in the prior calendar year. FTEs are never included in the penalty calculation itself.

When payroll systems, ACA-reporting vendors, or the IRS’s own matching process blur this line, treating part-time or equivalent figures as full-time employees, the proposed penalty balloons. Correcting that single category of error can dramatically reduce an assessment.

Who Should Pay Close Attention?

The ESRP rules reach a wide range of businesses. You should be especially attentive if you are:

• An Applicable Large Employer. Any business that averaged at least 50 full-time and full-time-equivalent employees in the prior calendar year is potentially subject to § 4980H, even if it never offered coverage and even if it operates on thin margins.
• A variable-hour, seasonal, or high-turnover employer. Restaurants, hospitality, retail, staffing, agriculture, home health, and similar industries are frequent targets, because fluctuating hours make full-time determinations difficult and prone to coding errors.
• A business with related entities. Under the controlled-group and affiliated-service-group rules of IRC §§ 414(b), (c), (m), and (o), commonly owned companies are combined to test ALE status, and the 30-employee reduction is allocated among them. Employers are often surprised to learn that separate corporations are treated as a single employer, and that employees can be misattributed between them.
• An employer whose workforce includes owners. Unlike some other ACA provisions, owner-employees may be counted in ways that affect the analysis. LLC members, partners, and S-corporation shareholders are frequently classified incorrectly in employer records.

Why ESRP Assessments Are Frequently Wrong

Because the proposed penalty is built from payroll data, ACA filings (Forms 1094-C and 1095-C), Marketplace records, and third-party vendor reporting, errors in any of those sources flow straight through to the assessment. Common problems include:

• Employees incorrectly classified as full-time;
• Part-time employees treated as full-time;
• Former or terminated employees still counted in monthly totals;
• New hires counted before any limited non-assessment period expired;
• Owners counted as assessable employees;
• Form 1095-C coding errors (particularly Line 14 and Line 16) that misstate what was actually offered;
• Incorrect Marketplace or Premium Tax Credit data; and
• Controlled-group misattribution of employees among related entities.

Common Defenses to a Proposed ESRP

Depending on the facts, a well-supported response may establish one or more of the following:

• The full-time employee count is overstated. Payroll coding, vendor reporting, or FTE confusion inflated the number of full-time employees.
• Part-time employees were improperly included. Employees averaging fewer than 130 hours per month generally should not be treated as full-time.
• The employee was not employed during the month at issue. Terminations, resignations, and months with no hours of service are commonly overlooked.
• A limited non-assessment period applies. Certain employees cannot trigger liability during their first full month of employment or during initial measurement and administrative periods.
• Coverage was in fact offered, affordable, and of minimum value. Affordability safe harbors and minimum-value documentation can defeat a § 4980H(b) proposal.
• The employee was misattributed under controlled-group rules. The wrong related entity may have been charged.
• The Premium Tax Credit trigger is unsupported. The IRS must establish that a qualifying full-time employee actually received an allowed credit for the months in question.

The Role of the Premium Tax Credit

The ESRP is only triggered when a full-time employee receives a Premium Tax Credit (or cost-sharing reduction) through the Marketplace. That single fact opens several lines of inquiry: Was the employee actually eligible? Was the credit ultimately allowed? For which specific months? And was the employee genuinely full-time during those months? If no qualifying employee received an allowed credit for a given month, no § 4980H(a) liability may apply for that month. Employees also generally cannot claim a credit when offered affordable, minimum-value coverage, so proving your offer can remove the trigger entirely.

How We Analyze an ESRP Case

Our review is methodical, because the penalty itself is built methodically. A typical engagement includes:

• Reviewing Letter 226-J and every attachment, including the response deadline;
• Reviewing the underlying filings, Forms 1094-C, 1095-C, and the Forms 14764 and 14765 in the packet;
• Analyzing payroll and hours-of-service records;
• Reconstructing the monthly full-time employee count;
• Identifying part-time employees, terminated employees, new hires, owners, and limited non-assessment periods;
• Examining each Premium Tax Credit “trigger” employee month by month;
• Preparing correction schedules and affordability safe-harbor calculations; and
• Drafting and submitting a targeted written response addressing each employee and month the IRS cited.

What Information We Typically Need

To evaluate a matter, we generally ask for:

• The IRS notice and all attachments, plus any prior response already sent;
• Forms 1094-C and 1095-C filed for the year at issue;
• Payroll reports and employee hours supporting full-time determinations;
• Documentation showing coverage was offered, and health-plan eligibility materials;
• Affordability safe-harbor calculations;
• An employee census; and
• Ownership records, operating agreements, and shareholder or controlled-group information.

What Happens After You Respond

After you submit Form 14764, the IRS acknowledges your response with a letter in the Letter 227 series. In brief: Letter 227-J confirms an agreed assessment; 227-K reduces the penalty to zero; 227-L revises the amount; 227-M leaves it unchanged; 227-N reflects an Appeals decision; and 227-O revises the amount for tax-exempt and government entities. If you disagree with the outcome, you can request a conference or review by the IRS Independent Office of Appeals. The objective at every stage is to present a clear factual record so the matter resolves administratively, without litigation. If the issue is not resolved, the IRS may formally assess the ESRP and issue Notice CP220J demanding payment, after which options include paying and pursuing a refund claim (and, if denied, a refund suit in federal court) or using collection-stage protections.

Possible Outcomes

Depending on the facts, an ESRP review may result in full withdrawal of the penalty, a significant reduction, a partial adjustment, or confirmation of the assessment. Every case is different, and the result turns on the strength of the documentation supporting your position.

Recent Developments Employers Should Know

Two developments since late 2024 have meaningfully changed the ESRP landscape.

A Longer Response Window and a New Statute of Limitations

The Employer Reporting Improvement Act, signed into law in December 2024, made two changes that directly help employers. First, it gives employers at least 90 days to respond to Letter 226-J, up from the prior 30-day window, for letters issued on or after January 1, 2025. Second, for the first time it establishes a six-year statute of limitations on ESRP assessments, running from the later of the due date of the employer’s Forms 1094-C/1095-C or the date they were actually filed. Previously, the IRS took the position that it could assess these penalties indefinitely. A related law, the Paperwork Burden Reduction Act, also lets employers furnish Form 1095-C only upon request (with proper notice) and permits using an individual’s date of birth where a taxpayer identification number is unavailable.

A Court Challenge to the Assessment Process

In Faulk Company, Inc. v. Becerra (N.D. Tex. 2025), a federal district court held that the IRS could not assess an ESRP where the required certification under ACA § 1411 had not been properly issued by the Department of Health and Human Services, and it ordered a refund of the penalty that employer had paid. The decision raises a potential additional procedural argument for challenging a Letter 226-J. Two important caveats apply: the ruling granted relief only to the employer in that case (there is no nationwide injunction), and it may be appealed. The IRS continues to issue and assess ESRPs. This is an evolving area, and whether it offers any benefit in a particular matter depends entirely on the specific facts, which is one more reason to have a notice reviewed by counsel promptly rather than relying on a single court decision.

Why Immediate Action Matters

ESRP matters are deadline-driven. A proposed assessment does not mean the IRS is correct, but ignoring it can make an incorrect penalty permanent. Failing to respond by the date on the letter may result in assessment of the full proposed liability, additional collection activity, and far greater difficulty correcting errors later. The proposed stage is almost always the best and least expensive opportunity to fix the record.

This article is provided for general informational purposes only and does not constitute legal or tax advice, nor does it create an attorney-client relationship. ESRP and ACA rules are complex and fact-specific, and penalty amounts are adjusted annually. You should consult qualified counsel regarding your particular circumstances before taking or refraining from any action. AnidjarLaw Tax Resolution Services can assist with complex tax matters.